Wednesday, December 12, 2018

Iceland holds rate, to prevent krona fall, ready to tighten

    Iceland's central bank left its key interest rate unchanged at 4.50 percent and while it reiterated that it would intervene to prevent a drop in the Icelandic krona from the government's plan to lift capital controls it also said it would tighten its monetary policy stance if inflation expectations continue to rise.
    The Central Bank of Iceland (CBI) last month raised its rate for the first time since November 2015 to curb rising inflation from strong economic growth and a fall in the krona.
     Despite a jump in November inflation to 3.3 percent from 2.8 percent in October, CBI said this rise was expected and while there are signs the positive output gap will continue to narrow, the rise in inflation expectations was still limited to short-term expectations and the fall in the krona has slowed.
    "The near-term monetary stance will depend on the interaction between a narrower output gap, wage-setting decisions, and developments in inflation and inflation expectations," CBI said.
     Iceland's economy slowed in the third quarter - zero percent growth from the second quarter and 2.6 percent annual growth - but expanded by 5 percent in the first nine months, slightly higher than forecast by CBI in November.
     Lasts month CBI raised its forecast for 2018 growth to 4.4 percent but maintained its forecast for growth to ease in 2019 to 2.7 percent and then slow further to 2.5 percent in 2020.
     Iceland's krona fell sharply from April through November but it has firmed in recent weeks and rose slightly in response to the central bank's decision. The krona was trading at 123.4 to the U.S. dollar, down 16 percent this year.
     On Friday Iceland's government proposed to the parliament that owners of offshore krona will be allowed to either close out their positions in full by swapping them for foreign currency in the onshore market or hold them as unrestricted krona assets in cases that involved continuous ownership from the time before the capital controls were imposed in the wake of the global financial crises.
     In addition, the government is preparing to sell its stake in two of the banks that were reestablished with domestic assets following the 2008 bankruptcy of their parent banks that failed during the financial crises.

     The Central Bank of Iceland issued the following statement:

"The Monetary Policy Committee (MPC) of the Central Bank of Iceland has decided to keep the Bank’s interest rates unchanged. The Bank’s key interest rate – the rate on seven-day term deposits – will therefore remain 4.5%. 
According to the recently published national accounts, GDP growth measured 5% for the first nine months of the year, slightly more than the Central Bank had assumed in its November forecast.
Inflation has risen over the course of the year, in line with the forecast, measuring 3.3% in November. The main driver of the increase was the steep rise in import prices in recent months, as the króna has depreciated by over 11% year-to-date.
This depreciation and concerns about upcoming wage settlements have shown in expectations of a further rise in inflation. The monetary stance as measured by the Central Bank’s real rate has therefore eased again. On the other hand, there are signs that the positive output gap will continue to narrow in the near term. In addition, the rise in inflation expectations since the last MPC meeting is still by and large limited to short-term expectations, and the depreciation of the króna has slowed. 
It has recently been announced that there are plans to release the last of the offshore króna assets that were locked in by the capital controls in the aftermath of the financial crisis. The resolution of such a legacy problem should not be allowed to lower the exchange rate of the króna; therefore, the Central Bank will intervene in the foreign exchange market, in line with previous statements. In this context, the Bank will also take into consideration that there are signs that the recent currency depreciation has pushed the real exchange rate below its equilibrium value.
The near-term monetary stance will depend on the interaction between a narrower output gap, wage-setting decisions, and developments in inflation and inflation expectations.
The MPC reiterates that it has both the will and the tools necessary to keep inflation at target over the long term. If inflation expectations continue to rise and remain persistently at a level above the target, it will call for a tighter monetary stance. Other decisions, particularly those relating to the labour market and fiscal policy, will then affect the sacrifice cost in terms of lower employment."


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